Bank Stocks Overcome Obstacles to Post Decent Earnings

Bank stocks are the first ones out of the gate for Earnings Season. As such, they set the tone for the entire earnings season—and looking at their reports will help us be forewarned as to what is yet to come. Before the start of earnings, there was a great deal of fear that bank stocks would set a poor tone for the rest of earnings season. As we round the corner on their earnings reports, it is looking like those fears were unfounded. Earnings have been coming in solid, and with some upside. Many of them are expressing caution for upcoming quarters.

The Setup: Earnings Estimates were dropping prior to earnings season. Bank stocks were struggling with a flat yield curve that was dropping their Net Interest Margins (defined next paragraph). While the economy was strong, low long term rates were not driving increased housing sales, and trading revenue was down from Q1.

Net interest margin is a primary driver for bank profitability. Bank stocks take in deposits, and pay the depositor a low interest rate. Then, they take that money and loan it out long term, and at much higher rates. When long term rates are as low as they are right now (with 10 year yields hovering around 2%), they are not getting the same large spread between short term rates and long term rates that helps to boost profits.

Analysts were clued in to this issue with the banks. They had brought their estimates down so far that they are now calling for Q2 earnings to be flat when compared to a year ago. This set the table for the banks to jump over this lowered bar. Many times, lowered estimates are actually a bullish indicator (which is kind of strange).

Let’s take a look at how three of these big bank stocks (Citibank, Wells Fargo and JP Morgan) did this quarter and what it may mean for the earnings quarter in general.

Bank Stock 1: J.P. Morgan (JPM)

Usually, JP Morgan is first out of the gate. Generally regarded as one of the best run banks in the industry, they have a solid franchise with exceptional risk management practices that have kept them out of serious trouble in recent years. They often are the first bank to report, but this quarter, Citigroup was so excited, they jumped the queue and reported the day before JPM.

JP Morgan’s quarter was considered solid but not spectacular. They have lifted earnings over 13% year over year, and revenue by 9%. They beat the estimates by a safe $.09. During their earnings call, they did indicate that their Net Interest Margin had decreased, but they felt that they had the matters at hand. Additionally, they got a boost from not having to increase their credit loss reserves.

The market was not overly impressed with the report, and JPM has traded sideways. Chaikin Analytics continues to rate JP Morgan as bullish. But it has entered into Overbought territory, and institutions have been pulling money out (see Chaikin Money Flow).

Bank Stock 2: Citigroup

Citigroup had a wild ride on the day of earnings before the market decided how they felt about Citigroup’s earnings. At the end of the day, this bank stock had rebounded from a 3% drop to essentially flat.

While the earnings were up from last year (also by 13%), the market expected a little more. Revenues were also up. Remember this is a stock that was up almost 50% year to date, so market watchers wanted to see more growth in earnings to justify the price growth.

Net/Net – this was another fair report.

Bank Stock 3: Wells Fargo

Wells has been in a rut recently. Beset with scandals, the market has not rewarded Wells as they have gradually put their house in order. This report was no exception. They beat estimates, had earnings growth over 20%, and good revenue growth.

What should have been a solid move upward turned ugly. Wells guided that they had some tougher times ahead, and that was enough to get the market moving in the opposite direction. Wells is down 20% over the past year, and has not enjoyed the bounce backs that other bank stocks have experienced.

Summary:

With bank stocks kicking off earnings season every quarter, they are important bellwethers that help set the tone. They certainly did their job this quarter, with solid earnings beats. But in a quarter where the market has seen estimate drops leading into the quarter, and valuations growing, they want more than a slight beat.

Nonetheless, they have now set the table. Their experience is most likely going to play out for other companies. The market is going to judge any company that misses earnings harshly. They aren’t going to be happy with bank stocks that barely beat or just attain estimates. They are going to look at forward guidance. With the market recently setting new highs, the market is looking for perfection before they reward a stock!

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